When you turn age 70.5, you must start taking a required minimum distribution (RMD) from your retirement accounts (except the Roth IRA). This is because you have enjoyed years of pre-tax growth in your investments, and the IRS would like to start collecting some tax. If you are still working when you turn 70.5 (and not a 5% or more owner of the business), you do not have to begin taking RMDs on assets in your 401(k).
Unfortunately, some retirees have assets built up outside of their pre-tax retirement accounts and don’t want to make distributions, as they are taxed at their ordinary income rate. For an individual that turns 70.5, they are required to withdraw 3.65% of their previous year-end account value. This percentage increases each year, until the account has been emptied.
For example, a retiree with a $1,000,000 Traditional IRA is required to withdraw approximately $36,500 before April 1 of the following year. However, they most likely will want to take the RMD in the current year, to avoid double RMD taxation in the following year. This basic scenario shows the importance of planning ahead.
What if the retiree doesn’t have a need for the amount they are required to withdraw each year? They will simply have to pay taxes on the distribution amount and keep in savings or reinvest the proceeds in a taxable account. With a little bit of planning ahead, retirees can greatly reduce the amount of RMDs they will face in the future by utilizing these three strategies.
1. Couples Maximize Younger Spouse Retirement Contributions
Households that have both spouses working should focus on filling up the younger spouse’s retirement accounts before filling up the older spouse’s accounts. This is because required distributions are based on the individual’s age. If the younger spouse has the larger retirement account, the larger required distributions won’t start until that spouse reaches age 70.5. Depending on the age difference between spouses, this could allow for years of additional tax-deferred growth in the household’s collective retirement accounts.
Extra consideration should take place to make sure each spouse is receiving the full matching contribution from their employers.
2. Partial Roth Conversions Pre-70.5
For individuals that retire before reaching age 70.5, there will be a large reduction in the amount of earned income they realize. This provides a tremendous opportunity to “fill up” the lower tax brackets by making partial Roth conversions until reaching age 70.5.
In 2018, Married Filing Jointly households can convert a portion of their pre-tax retirement accounts into their Roth IRA up to $165,000 of taxable income, while still maintaining the 22% tax bracket. By converting pre-tax dollars to the Roth IRA, retirees can maintain a low tax bracket and now allow those dollars to grow tax-free (with no required minimum distributions).
3. Qualified Charitable Distributions
So what happens if you have favored contributions to the younger spouse, completed partial Roth conversions leading up to age 70.5, but still have an RMD to take that you don’t need? The Qualified Charitable Distribution (QCD) is another great option. For the charitably inclined, you may make a direct transfer from your IRA to the qualified charity of your choice. The QCD will satisfy the amount of RMD you need to take, up to $100,000 per year. Therefore, if you have a $30,000 RMD to take that you don’t need, you may send that $30,000 directly to a charity and avoid having to pay taxes on the distribution.
With the increased Standard Deduction now in place due to the Tax Cuts and Jobs Act of 2017, receiving a tax deduction for charitable contributions is tougher than years past. By making a QCD instead of the normal RMD, you can both avoid tax on the distribution and enjoy the tax benefits of giving to charity.